Bank Shocks, Financial Constraints, and Targeting Behavior: Evidence from Credit Supply Fluctuations

Abstract

This study investigates whether fluctuations in credit supply in a macroeconomy and a relational bank’s financial condition affect the capital structure adjustment of firms. Using data for Japanese listed firms from 1988 to 2014, we find that firms adjust their capital structure slower during credit contraction periods than during other periods, and that the effects of credit market tightness are more evident for small firms. Examining firm-bank matched data, we also find that credit supply shocks have heterogeneous effects on the rebalancing behavior of firms. Firms that are associated with banks that have limited capacity to supply loans or those associated with failed banks show a slower adjustment, thereby suggesting that a bank’s financial weakness places the leverage of relationship firms into a suboptimal level for a long period of time. These findings suggest that bank supply shocks play a significant role in the targeting behavior of firms.